5. This question goes back to the relationship between elasticity and revenue. We saw that with a price increase, revenue tends to rise due to the greater price paid per unit sold, but tends to fall due to the reduced number of units sold. Whether revenue actually increases or decreases, depends on which effect is stronger. The overall effect on revenue from an increase or decrease in price depends on demand elasticity. If demand is inelastic, regardless of which way price changes, we know that %
Q < %P, and if demand is elastic %Q > %P. In this question, elasticity is 3.5; meaning that demand is elastic. Specifically, it means that %Q = -3.5 x %P; or a percentage change in price leads to a percentage change in quantity 3.5 times greater, in the opposite direction. This means that if the firm lowers price, quantity sold will increase a great deal, causing revenue to increase.
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